Wall Street's New Data Pair Trade: Buy Alliance Data, Sell WEX

In a new research note on the data processing sector, JP Morgan analyst Tien-tsin Huang said that the sector's outperformance should continue heading into 2016.

The underlying macro trends that have helped these equities outperform during 21 of the past 25 years are still present, including a "favorable pricing environment, a bias toward outsourcing given client regulation concerns and low disintermediation risk." Further, given M&A pressures, Huang said that high valuations can persist for some time.

In the note, Huang upgraded Alliance Data Systems Corporation (NYSE: ADS) to Overweight, while the firm cut WEX Inc (NYSE: WEX) to Underweight. JP Morgan cut WEX on concerns over a "stretched" valuation and relative lower growth. The firm noted that WEX was the one company where its FY16 expected EPS was the most different from Wall Street's consensus.

Alliance Data's recent sell-off is what spurred the upgrade. The stock was trading above $300 in mid-July before falling to close Thursday at $268.92 – a decline of more than 10 percent. The risk/reward setup is "more favorable at current levels, particularly in light of management's strong track record," Huang added.

Across the industry, JP Morgan said that the stocks it is most favorable on include VeriFone Systems Inc (NYSE: PAY) and TriNet Group Inc (NYSE: TNET). Both are rated Overweight. The analysts also like Evertec Inc (NYSE: EVTC), which they rated Neutral, if sentiment begins to shift.